Interview

Tim Tacchi and Mark Williams

INTERVIEW

As demand for alternative investments continues to grow, the lines between hedge funds and traditional long only managers are becoming increasingly blurred. Some managers, however, have always maintained a strong presence in both areas of asset management. On 1 September, the day on which TT International celebrated the twentieth anniversary of its founding, The Hedge Fund Journal spoke with Tim Tacchi, its Founding Partner, and Mark Williams, Senior Partner, about the company's investment philosophy.

TT International was founded in 1988, initially to manage European equities for a well-known US hedge fund. It now has US$3 billion AUM in hedge funds, as well as a further US$19.9 billion AUM in high alpha actively managed long only funds. At first glance the development of a large long only business from a starting point in hedge funds may appear unusual, but in fact it is an expression of the same investment approach applied to different strategies.

"We had always intended to build a business aimed at sophisticated professional clients," says Mark Williams. "That for us has always included endowments, financial institutions, corporates (primarily their pension funds), governments (in the form of sovereign wealth funds), and family offices."

"The aim was always to have a brand that was high alpha," continues Williams. "Our ability to manage risk, either long or short, and to be benchmark agnostic (ie. a willingness to take substantial bets away from the benchmark in long only investment) meant we could take our hedge fund skills and offer them to the more traditional sophisticated institutional client base. That's precisely what has happened and we have hit a rich seam of opportunity."

The trend, increasingly apparent in the wake of the credit crunch, for hedge funds to become larger and more institutionalised has contributed to this weaker demarcation between the alternative investment and long only industries. "Twenty years ago you could start out in a very small way," says Tim Tacchi. "The regulatory burden was lighter. Today that's quite different. The levels of control and risk assessment that you need to put in place are hugely more sophisticated than they were even just five years ago." Tacchi believes that the much greater rigour on the part of, not only clients, but their intermediaries and consultants, means that the due diligence requirements for a hedge fund manager are now no different from institutional long only businesses.

"The structure," adds Williams, "is already pretty evident where on the one hand you have long only managers who can demonstrate alpha generation and can offer absolute return strategies and on the other hand, the smarter and better hedge funds which can offer benchmark-agnostic long only product so long as they can provide the associated complex support functionality that the sophisticated investor wants."

Where the path divides

TT International believes that the industry will increasingly bifurcate into two types of investment, which can be characterised as "dull and boring" and "hot and spicy". The former are passive index-tracking strategies, while the latter, whether in long/short or long only, are actively managed. "People are willing to pay for the delivery of alpha, but not for bland performance," says Williams. TT International, therefore, is happy to offer a performance-based fee structure on long only products as well as its hedge funds.

In practical terms this investment approach translates into targeted returns of 15%-20% per annum in absolute return hedge fund strategies and 3%-5% over the benchmark in long onlyproducts. "People don't see us in the hedge fund world as managers of 'shoot the lights out' funds," says Williams. "If you deliver 15%-20% reasonably consistently, you will be attractive to investors and will be delivering a good long term return. People are willing to take a longer term view, because the ability to deliver returns over a period of time is crucial."

Investment opportunities

An important tenet of TT's philosophy is the belief that "staying away from trouble" is critical to maximising returns and minimising risk. Tacchi points to evidence of this philosophy in TT's recent performance, "In the last 12 months the TT Financials Long/Short Fund has been net short and the long only funds, where financials are between 20-25% of their benchmark, have had only a very small exposure to the sector." Staying away from trouble is also easier when you are prepared to be different, which is another of TT's differentiating characteristics. "We are prepared to be significantly short in our long/short funds and not just for a day or two," says Tacchi, drawing a distinction between TT and some of its peers, which retain a marked long bias in their long/ short portfolios. For example, the TT Financials Long/Short Fund, which is up 30.7% in the 12 months to 31 August and the TT Mid-Cap Europe Fund, which is up 20.1% over the same period, have both been net short for the vast majority of the last year. Williams, meanwhile, also believes that the combination of bottom-up and top-down analysis favoured by TT is further evidence of this willingness to be different.

There is no specific target for the ratio of hedge fund to long only strategies within TT's book of business and the relative proportions of the two have changed over time. "We look at the business as a whole and decide in which products there is available capacity, whether long/short or long only, and clearly we fish in the same sea," says Tacchi. "The idea generation is effectively the same group of people coming up with ideas that are then populated in different portfolios."

TT International expects to continue to launch hedge fund products where it sees opportunities to meet investor demand, but only where it has a competitive advantage. The firm's philosophy is to do a few things very well rather than try to do everything. The most significant areas of recent development have been the launch of the TT Financials Long/Short Fund in March 2006 and expansion in Asia. TT opened an office in Hong Kong in 2004 and from there, through its Hong Kong subsidiary, manages two hedge fund products; the TT Long/Short Japan Fund and the firm's most recent offering, the TT Asian Opportunities Fund, which was launched in October 2007. "As with all our products, the latest two have evolved out of our core competency in international equities," explains Tacchi. As with the European funds, the Asian products combine bottom-up stock picking with a top-down thematic approach.

While stock research is paramount, TT places emphasis on the value added to the investment process through its top-down "What time is it" analysis. The name was chosen to reflect the company's aim of ensuring that the positions in its portfolios reflect its current views. "We sometimes use a sailing analogy," says Williams. "You know that you want to get from A to B, but you have to constantly adjust the sails and the tiller to deal with changes in the wind conditions and tides." TT constantly analyses whether its portfolio reflects the themes that the market is looking at and also whether those themes are priced effectively. "If the themes are evident but there is no price dislocation there is not an opportunity to make money," says Williams. As well as allowing TT to monitor its existing portfolios the process also helps identify completely new opportunities, akin to "shining a torch in a dark room".

In practice "What time is it?" entails meetings twice a month at which the firm's fund managers analyse the sectors or countries they are responsible for. "We also review, in detail, the macroeconomic data for the world's major developed and developing economies to form a view on what is changing in the world economy," says Tacchi, who personally conducts this review about half of the time. From this combination of bottom-up analysis by the specialist fund managers and the top down macroeconomic review, investment themes emerge. Any fixed income and currency positions that the company takes are driven directly by the top-down analysis and the equity fund managers are "encouraged" to incorporate the themes into their portfolios. A top-down "house view" is not imposed on managers, although Tacchi points out that if managers do not respond to encouragement in a particular direction and returns are "not where they need to be" then that encouragement becomes more persuasive.

Williams, however, notes the important distinction between risk management, which is a separate function, and the encouragement of managers' conviction levels. "When people have really good ideas you encourage them to back them. It's about reading people as well as risk." "In a bear market you encourage the bears and restrain the bulls, while in a bull market you do the reverse," adds Tacchi. "That's the skill of it."

Good prospects for alpha generators

TT International's current top-down view of the most likely macroeconomic scenario, to which it attaches a 60% probability, is one in which oil prices stabilise between US$100 – US$130 a barrel, food prices, therefore, stop going up because the two are inextricably linked and upward pressure on inflation eases. Lower inflation will allow personal incomes to recover and allow modest increases in consumption, while reducing the squeeze on companies by lowering PPI. Lower inflation will also make it possible for central banks to ease monetary policy.

"The problem," says Tacchi, "is that the risks to this benign outcome seem all to be on the downside. If the corporate sector decides to shed labour and reduce capital investment you will enter a selfreinforcing down cycle. Obviously, the down cycle doesn't last forever. Eventually you reach a point where asset prices become cheap, inflation has fallen and central banks are able to cut interest rates, but we ain't there yet. Even if the 60% probability is correct, given that we believe the risks are on the downside, it is a very treacherous environment."

Despite this potential for further weakness in equities, Tacchi is upbeat about the prospects for investment. "It's still quite early in the cycle to think that equities have bottomed. But this should be a good environment for high alpha generators."

Biographies

TIM TACCHI

Tim Tacchi is the Senior and Founding Partner of TT International. He is responsible for asset allocation and heads European stock selection. Prior to establishing the firm in 1988, Tim was an Investment Director with Fidelity International, responsible for UK and European ERISA business, including stock selection and client relationships. Before joining Fidelity he was an Investment Manager for the UK-based merchant bank Hambros. Tim graduated with an MA from Oxford University.

MARK WILLIAMS

Mark Williams is a senior partner of TT International. He has over 25 years' industry experience and joined the firm in 1994. His responsibilities include geopolitics and currency management. Prior to joining TT, Mark worked for seven years at Goldman Sachs where he held a number of senior positions including Co-Head of Foreign Exchange in Europe. Mark received his BA from Durham University and undertook postgraduate studies at both The Guildhall School of Music & Drama and London Business School.